The Smart 401KJohn Meehan and Jeffrey M. Laderman
General Motors Corp. sponsors an ambitious seminar program--some 1,000 meetings in all--to talk about it with employees. E! Entertainment Television, the gossipy cable network, takes a glitzy approach, publicizing it through a barrage of voice-mail messages, E-mails, and posters. J.B. Hunt Transport Services Inc., a trucking company based in Lowell, Ark., spreads the word to its itinerant workforce through audio cassettes that can be played on long journeys.
The topic of this blitz is not a standard management theme such as improved quality or productivity. The communication crusade, repeated at companies nationwide, is focused squarely on--of all things--the 401(k). The 14-year-old pension program, which gets its uninspired name from the Internal Revenue Service code that led to its creation, has been one of the most misunderstood and poorly used of corporate benefits. But companies, increasingly fearful that they can't afford to tolerate such neglect, are scrambling to remake the 401(k).
PORTABLE. The stakes go well beyond employee morale and well-being. Poor participation by lower-paid workers curbs the ability of the higher-paid to make full use of the 401(k), because contribution limits are calculated on average company participation. What's more, managers want to preserve the 401(k) and its portability, which makes it ideal for an era of downsizing. Companies don't have to fret over pension liabilities that linger long after layoffs and early retirements, since employees take their 401(k) money when they leave.
Employers are also worried about potential legal fallout. If future retirees find that their 401(k) money is insufficient, they can accuse employers of not showing them properly how to use the program. Recent regulations that many companies hoped would reduce their fiduciary responsibility for 401(k) plans fell far short of doing that. Aside from protecting employers if a worker makes a bad investment choice, the Labor Dept.'s so-called 404(c) rules, which went into effect in January, 1994, hold employers accountable for picking sound investment options and capable money managers. The rules also suggest that employers offer at least three investment choices of varying risk, not including company stock, and educate employees about their options. But it's not clear what's adequate education, and companies fear straying over the fine line between education and outright advice. Labor is expected to issue guidelines on 401(k) education in August.
Although the new voluntary regulations provide some standards for 401(k) plans, most managers believe that their companies may be at risk even if they comply. A 1994 survey by Greenwich Associates of 1,600 big corporate pension-plan managers found that two out of three don't believe 404(c) offers them much protection from future lawsuits from employees with underfunded 401(k) plans. "It covers an inch on the yardstick of fiduciary exposure," cautions Brian Ternoey, a principal at benefits consultant A. Foster Higgins.
If future retirees find themselves barely scraping by, they'll look to Uncle Sam for help--and it's unlikely that Social Security benefits will rise to the occasion. Absent big changes, the system is projected to run a cash-flow deficit by 2013, around the time the baby boomers start retiring (chart, page 60). And the average boomer doesn't have much of a nest egg. Although the 401(k) is having a positive impact on savings, the personal savings rate in the 1990s is only 4.6% of income, down from 6.5% in the 1980s. "We tell people: `If you want to maintain your standard of living, you have to be in the 401(k),"' says Rex R. Gooch, benefits manager at Coors Brewing Co.
There's little chance companies will return to the paternalistic era of retirement funding. A mobile workforce and flexible staffing needs favor the 401(k). Consider IBM. Employees at Big Blue, whose workforce has shrunk by 46% since 1986, to 220,000, look upon the traditional plan as their major source of retirement income. But earlier this year, the computer giant--at the expense of its pension plan--doubled its 401(k) matching contribution, to 50 cents for each $1 of the first 6% that employees contribute. "That sends a message that this plan is important," says Donald Sauvigne, who oversees IBM's retirement programs.
WORKHORSE. The 401(k) is also cheaper and easier to use because companies don't have to deal with as many regulations and reporting requirements. For small companies, with limited resources, the 401(k) is all they can afford. "It's nearly impossible for a small company to set up a defined-benefit plan," says Gail Keppler, chief operating officer of the Vanderveer Group Inc., a small health-care marketing outfit in Ft. Washington, Pa. "The cost would be crushing." Small wonder 401(k) assets have grown by a hefty 73% since 1989, to nearly $1 trillion. By contrast, traditional corporate pensions have increased at less than half that rate, to $1.5 trillion.
With the 401(k) shouldering more of the burden, the Labor Dept. this summer will launch a national ad campaign to draw attention to retirement planning and the need for higher savings, and to encourage better use of 401(k) programs. And Arthur Levitt Jr., chairman of the Securities & Exchange Commission, is embarking on a series of town-hall meetings with unions and public pension funds this fall to warn employees that they have to be smarter about 401(k) plans. Educating the public about savings plans "is a critical national priority," says Levitt.
Companies are certainly behaving as if it were. They're trolling for participants while expanding menus to include such choices as international and small-cap stock funds that pack more punch. Some companies add "lifestyle" funds, so employees can choose funds depending on how much risk they want--and the fund manager takes care of asset allocation. On Mar. 1, for instance, GM added 31 Fidelity Investments mutual funds to its seven investment options, three of which were GM stock. At the same time, managers are bombarding their charges with newsletters, videos, contests, and computer software on how to master the perceived complexities of the 401(k).
Enlightening employees about the 401(k) may be one of Corporate America's toughest tasks. Under the traditional pension, or defined-benefit plan, employers used actuaries and professional money managers to make investments. If a company made a lousy call, it would make up the difference. And if the company failed, a U.S. government agency would help out retirees. But with the 401(k), decisions about how much to put in and how to invest it are left up to the 18 million individuals enrolled.
Employees have gotten a little smarter about their 401(k)s and other defined-contribution plans. Education efforts have helped. So has the passage of time. With the oldest baby boomers nearing 50, retirement is no longer the imponderable it once was. But most people, even those quite talented in their professions, just aren't prepared to tackle the finer points of asset allocation. Nor, it seems, are they interested in doing so.
Their insouciance shows in telling ways. Consider: One person out of every four eligible does not participate in a plan (chart, page 60), and the average contribution of those who do is 7.5% of pretax income, though experts believe it would ideally be several points higher. Another problem: Too many aren't fully informed about their 401(k) investment choices or forget about their plans altogether after signing up. A recent survey of 1,000 employees across varying salary scales by benefits consultant Towers Perrin found that 39% of participants in 401(k) and other savings plans have no idea how their assets are allocated.
SURE CARROT. Most worrisome, the allocations in 401(k)s are awry. True, 75% of new money pouring into 401(k) programs is funneled into equities. But assets in the plans remain split roughly 50-50 between lower-risk, yield-oriented investments and higher-risk but higher-return equities. Defined-benefit plans typically allocate 60% to 65% of assets to a diversified portfolio of stocks. More alarming: 23% of the 401(k) money is in the stock of the employee's company, according to Access Research Inc., a Windsor (Conn.) consultant specializing in 401(k)s. Company stock exposes an employee's 401(k) to great risk if the employer's fortunes head south.
The immediate challenge for many companies is just to get employees thinking about retirement. That was the goal of E! Entertainment's "Stash Your Cash" program. The average age of the company's 325 employees is 30, so managers turned to a multimedia strategy and a catchy name to get their attention. "I knew if I just came up with `E!'s 401(k),' it would be a big ho-hummer," recalls Patricia M. Robinson, senior vice-president at E! Entertainment. It has maintained interest by increasing the company contribution--a sure carrot for most employees. In January, it went from 40 cents to 50 cents on the dollar, up to $1,500 tops.
The campaign certainly struck a chord with Robert Sheiffele, a 34-year-old talent executive at E! Although he's at a tender age career-wise, Sheiffele credits E!'s program and subsequent seminars for enhancing his 401(k) awareness. He salts away 8% of his pretax salary in the 401(k) plan. True, two-thirds of his assets are in low-yielding investments. But it's a start. "It's a nice, secure feeling that I won't have to live in a cardboard box in my old age," he says.
J.B. Hunt had similar success with its cassette tapes, one of which began with a somber warning: "Don't get lost on the road to retirement." After listening to the tapes, Gary L. Brown, 43, attended a seminar at his company's depot and signed up for the 401(k) plan in October. "I want to be able to live comfortably," says Brown, who sets aside 4% of his $30,000 salary, while Hunt contributes 2%. Thanks largely to the tapes, Brown's bosses say the company's 401(k) participation rate went from 47% to 67% of eligible employees.
SPOON-FEEDING. For lower-paid workers, easy access to their money is crucial. Working with plan provider Metropolitan Life Insurance Co., Kit Manufacturing Co., a $90 million manufacturer of mobile and modular homes, gives its hourly workers a toll-free number to call to arrange loans from their 401(k)s. Workers punch in the amount they need over the phone. A check arrives within four days. If blue-collar employees get injured or financially strapped, "they may need money and have to have it real fast," says Dale J. Gonzalez, treasurer of the Long Beach (Calif.) company.
It's one thing to enroll employees. But it's much harder to get them to invest wisely (chart, page 60). Companies, more at ease discussing customers and cycle-times, are hiring outsiders to talk to employees about the risks and rewards of stocks and bonds and the importance of asset allocation. By spoon-feeding employees small doses over time, companies hope the information sinks in.
It certainly did with Debbie Thomas, 43, director of public policy at U S West Communications Inc., U S West's phone unit. "I didn't know much about finance, and I didn't want to know," says Thomas, who worked for the company for seven years before she enrolled in its plan. Then, she made no effort at asset allocation, letting the money accumulate in a low-yield income fund and U S West stock. But last year, after a presentation by a company benefits executive, she reallocated her savings into a domestic stock fund and an international stock fund, in addition to her U S West shares, and she contributes a fat 16% of her annual income to the plan. Says Thomas: "One of the good things about the company program is they give you good information in real layperson's terms. You don't have to know finance to understand this stuff."
Some companies have also turned to user-friendly tools to explain the 401(k). Aluminum Co. of America installed touch-screen terminals at many of its facilities so workers can check on their portfolios. The terminals make it easy to play "what if?" games by modeling new portfolios and potential returns. "I punch in all kinds of projections," says Dick Kluger, 57, a maintenance mechanic at Alcoa's plant in Davenport, Iowa.
Although fixing the 401(k) has taken on a new urgency with employers, the old employee habits die hard. R.R. Donnelley & Sons Co., the $4.9 billion Chicago-based printer, began installing computer terminals 18 months ago in the lobbies and cafeterias of its 40 facilities so that its employees could keep tabs on their investments. Yet $300 million out of the $360 million in Donnelley's 401(k) plan languishes in the most conservative investment options. "It takes time for people to make other choices," remarks Dewey Ingham, Donnelley's vice-president for compensation and benefits.
LEGAL QUANDARIES. The challenge to educate employees is getting steeper for many companies as they expand their 401(k) plans to include more investment choices. Many employees are overwhelmed by the torrent of information they're receiving. "The issue is clutter," complains Wayne G. Bogosian, director of personal financial education at Watson Wyatt Worldwide, the management consultant. "Just because you give employees something to read doesn't mean they're educated."
Some companies are trying a personalized approach to overcome information overload. IBM offers employees free consultation with Merrill Lynch & Co. or American Express Co. Financial Advisors and will also contribute $250 toward purchase of a detailed plan. Next year, GM will offer retirement planning as an option in its benefits package. "People want to be told what to do," says Ruth Hughes-Guden, a managing director at RogersCasey, a Darien (Conn.) pension consultant.
As companies go about trying to revamp the 401(k), legal quandaries and intractable employees aren't the only hurdles to overcome. So are budget-conscious forces in Washington. To make up for lost tariff revenue under the General Agreement on Tariffs & Trade, Congress froze 1995's maximum tax-free 401(k) contribution at $9,240, unchanged from 1994. Previously, the limit was raised to make up for inflation. Congress also made changes so that future increases in contribution limits may trail inflation. Despite the Republican Congress' lip service to savings and investment, it's unlikely that lawmakers will keep their hands off the 401(k). "Not while we are trying to balance the budget by 2002, and I regret that," concedes Representative Bill Archer (R-Tex.), chairman of the House Ways & Means Committee.
As the bond between employers and employees is changing, so is the nature of retirement funding. For now, at least, that means baby boomers and the generations to follow have no choice but to master the fundamentals of the 401(k). That's the best way to guarantee a comfortable retirement for employees--and a tranquil one for employers.
The Smart 401(k) Plan
INVESTMENTS It should offer at least five choices, including a money-market or "stable value" fund, an equity index fund, large-cap and small-cap managed equity funds, and an international equity fund.
EDUCATION Investment education is constant, not just available when plans are launched or during enrollment campaigns. Talks by investment pros are good, small-group and individual consultations are better. Software and audio-visual materials help.
COSTS If using mutual funds, the funds should be no-load or the no-load shares of load-fund families. Funds should have low expenses and should not carry any redemption fees or surrender charges. Administrative costs are kept to a minimum.
VALUATION Accounts should be valued daily, allowing the participants to call a toll-free number to check on their balances. Participants should be able to move funds at any time. Unlimited transactions are the norm, but a limit of 10 or 12 per year is not unreasonable if it saves on costs.
LOANS Participants should be able to borrow as much as 50% of the value of their plan and pay back the loan at a market rate of interest.
CONTRIBUTIONS The employer offers matching contributions, the more generous the better. Employees should be eligible for the program as soon as they start work, even if the company delays matching. The plan should allow aftertax contributions by employees.